Rethinking Deficit Spending In The UK Spring Statement

Linda Yueh, Adjunct Professor of Economics, London Business School and author of "The Great Economists: How Their Ideas Can Help Us Today."

Borrowing to invest and counting it separately from day-to-day government spending was an idea proposed by John Maynard Keynes after the last systemic banking crash. He proposed that governments should separate out investment or capital spending from the current spending on welfare, etc. by the government. This way investment that can generate future economic returns to growth can be separated out and the greater transparency offered by counting it separately can help assuage fears of investors. The concerns over the budget deficit since the banking crash have centred on this concern about investor perceptions about the UK as an attractive country to lend to, which determines borrowing costs.

In the Spring Statement, the Chancellor of the Exchequer has done just this. Philip Hammond said that the UK will run a current budget surplus in 2018-19, so it will be borrowing only to invest. The Office for Budgetary Responsibility (OBR) estimates the budget deficit in that year will be 1.8% of GDP, then falling to 1.6%, 1.3%, 1.1%, and to 0.9% in 2022-23. Public debt is now expected to peak in 85.6% in this tax year and fall thereafter, even figuring in borrowing to invest in capital spending.

Chancellor of the Exchequer Philip Hammond leaves Downing Street in central London to announce the Spring Statement in the House of Commons on March 13, 2018 in London, England. (Wiktor Szymanowicz / Barcroft Media via Getty Images)

Keynes was supportive of governments borrowing to invest since he believed the economy usually operated below its potential and public investment should therefore supplement private investment. He believed that since state investment would boost economic growth, it would not mean that government debt would increase as share of GDP. Fast forward to now, that is also the conclusion of the OECD who estimated that raising investment by 0.5% of GDP would increase the size of the economy by at least that amount.

Keynes was the first to point out that there is no ‘crowding out’ of private investment when the economy is operating below its potential. ‘Crowding out’ refers to how governments borrowing to invest would make it harder for private firms to do so because their demand for loans would push up the interest rate and make it more expensive for others to borrow. However, since the British economy lost over 6 per cent of its output during the 2008 recession, and interest rates for loans are low, ‘crowding out’ would be unlikely, because the economy has lost so much output that there is a lot of scope for the public and private sectors to invest before their demand for funds pushed up borrowing costs. Moreover, increasing public investment can help economic growth, as it can have a ‘crowding in’ effect. In other words, government investment can make private investment more efficient, for example a good telecoms infrastructure increases the returns to a pound invested by a private company by giving them the fibre network to deliver faster services.

The Spring Statement shows that the UK is not aiming to eliminate the overall budget deficit and is instead focused on borrowing to increase spending in roads and housing as well as digital infrastructure. As bond investors’ concerns have shifted from deficits more towards slow economic growth, Britain’s growing emphasis on improving growth through investment, even if it means borrowing, is unlikely to shake markets. And indeed today’s announcement hasn’t.